Where next for the Footsie?

Unemployment is rising, the Bank of England looks set to hike interest rates again and consumers are showing signs of losing their appetite for purchases.

The picture hardly lends itself to a record surge in stock market confidence, but this is what has happened in recent weeks after the FTSE 100 Index peaked at just below 6,200 and reached levels last seen in early 2001.

As always, the milestone sparked another round of debate about whether the Footsie has further to go.

We've been in this situation before, of course. Last April saw the Footsie peak at 6136.5, only for a stand-off between the UN and Iran over its nuclear programme and war between Israel and Hezbollah militants in Lebanon to cause a sell-off.

North Korea's weapons policy and economic prospects remain potential worries, but whatever happens it is likely this year will exceed expectations.

A poll of eight market commentators at the end of last year - when the Footsie stood at 5618 - suggested the top flight would hit between 5600 and 6200. The doom-mongers saw little growth in 2006 with broker Morgan Stanley predicting the market would end the year near to where it started at 5600.

Those in the more optimistic camp, such as Richard Hunter, head of equities at Hargrevaes Landsown, forecast the Footsie to hit 6000 on the back of easing interest rates, merger activity and strong corporate earnings. ABN Amro's Lars Kreckel had been even more optimistic and predicted a rise to 6200.

And, while hopes the FTSE can finish the year ahead of its 6930.2 all-time high - reached on the final day of the last millennium - have faded, the feeling is that the momentum will roll on.

Dhaval Joshi, global strategist at SG Securities, said 'he wouldn't be surprised' if the market picked up almost 5% in the next couple of months to finish the year at around the 6,500 mark.

He said November's anticipated rise in interest rates, as well as higher fuel bills, had already been factored in and were unlikely to trip up the Footsie.

Investors see little reason for a downside, earnings are strong and there is a feeling the UK's debt problem is controllable, while the housing market appears pretty stable - despite fears of a crash earlier in the year.

The rally for the Footsie at the start of the year reflects fevered takeover activity, something which has returned after a summer lull with deals worth a total of £10bn for AWG and privately-owned Thames Water and the prospect of a £4bn takeover of Corus.

The fact that the bidder for Corus comes from India highlights the influx of new cash and expertise into markets such as London, as well as the opportunities for UK companies to expand into emerging markets.

The private equity coffers are said to be full to bursting and fund managers have money to spend after a strong year of share buy-backs.

Although the UK economy is growing to trend, it is worth remembering that the FTSE 100 Index is heavily weighted towards companies who make a large chunk of their profits overseas - such as the mining stocks.

Even a stalwart UK company like Tesco generates around £8bn of sales a year from overseas.

The powerful spur from the US cannot be ignored, where the Dow Jones is breaking records - just when Americans are fearing a housing and economic slowdown. It seems if the US is smiling, we are all happy.

Mike Lenhoff, chief strategist at Brewin Dolphin Securities, believes the euphoric feeling in the City is being heavily influenced by the US markets and a string of big earning companies.

He said: 'It's worth remembering that between 30% and 40% of sales for US companies come from outside the country. Yes, the US economy is slowing, but earnings are still surprising on the upside. The rest of the global economy is still growing, look at China, and in Europe there has been no loss of momentum, which is encouraging for the US market.'

While fears over inflation in the US and its impact on interest rates appear to have waned, nobody is particularly expectant about the performance in 2007.

In theory that should prove a drag for shares, but in fact investors may well have been cheered by the fact that a US housing slowdown could make the Federal Reserve less likely to hike interest rates.

Meanwhile, the price of crude oil is in an interesting position for the market. At around 60 US dollars a barrel, it remains high enough to support oil majors such as BP, while giving firms some room to move with margins.

Metal prices also continue to bolster the heavyweight miners, who have such a strong hold on the direction on the Footsie.

All in all, influences at home and abroad seem to signal a strong end to the year for the Footsie.

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Mr Hunter said: 'On the whole the positives within the market for the year to date seem to have remained intact.

'The strength of corporate earnings continued to please, the return of cash to shareholders saw major buyback programmes - all of which may well find their way back into the market at some point - and the amount of private equity capital on the sidelines, waiting to be invested is estimated at a 320bn US dollars (£171bn).

'In addition to this, some of the jitters from earlier in the year were displaced which meant that the third quarter left the market in fairly robust shape going into the last and final quarter.'

But perhaps there should be a reality check. The market is still way short of its all-time high, while European markets - although growing - have failed to keep pace with the energetic Footsie.

There are also tentative signs it could all come crashing down - inflation in high street prices for the first time in five years and record levels for debt for the UK consumer do not bode well.

Justin Urquhart-Stewart, a director at Seven Investment Management, warned against over-optimism and queried where the market will take its lead in the next 12 months.

'Let's not get carried away with the Emperor's new clothes. We have seen a lot of activity caused by mergers and acquisition, such as BAA and Corus, and people are eagerly speculating on the next move.

'People have been attracted to the large cap companies, both in the FTSE and the Dow, but the global economy is starting to apply the brakes and we have to ask where is the growth going to come from?

'There are concerns over inflation, especially on the things we have to pay for such as council tax and utility bills, and our economy is 65% based on consumer spending - I don't have as much spending power as I did.'

And Tom Hougaard, chief market strategist at City Index, thinks the US will start to have a negative impact on the UK - probably reducing the FTSE 100 to around 5,800 as the market gets a reality check.

He said: 'The US may be heading into a recession in the early part of 2007 and we will soon see some of that beginning to be priced into the market. At the moment, there is a euphoric feeling, but I just don't buy into suggestions it will hit 7,000 by the end of the year - that would take another 15% in three months.'